UPDATE 1-Telefonica to list German business in fourth quarter

* Telefonica to list German unit by end-year

* Firm promises 500 mln euro dividend payout in 2013

* Listing part of programme to reduce 57 bln euro debt

* Telefonica smallest player in Germany, room to grow

MADRID, Oct 3 (Reuters) - Spain's Telefonica said on Wednesday it expected to list its German mobile phone business 02 in the fourth quarter and promised potential investors 500 million euros ($647 million) in cash dividends next year.

The flotation is part of Telefonica's efforts to cut its huge debts to keep its prized investment grade credit rating, under threat from the troubles of its native Spain.

The Spanish company must raise 7-8 billion euros a year through 2015 to cover debt repayments and risks rising refinancing costs if Spain loses its investment grade rating.

On Tuesday, credit rating agency Standard & Poor's said Telefonica had the weakest credit profile of Europe's seven former telecom incumbents.

The company did not say how much of O2 Germany it planned to float. A financial source told Reuters the firm wanted to list between 10 and 20 percent of the business, which it has valued at 10 billion euros.

A person familiar with the process said Telefonica still planned to list it by end-October.

The listing will not significantly cut the company's huge debts, but analysts say it will provide ready cash for Telefonica, which is hampered by high borrowing rates.

In Germany, Telefonica's 02 brand is the smallest operator with roughly 16.4 percent of subscribers, trailing KPN's E-Plus , Deutsche Telekom and Vodafone .

But analysts say room for growth makes O2 Germany an attractive prospect for investors, plus the promised dividend payment, which Telefonica said will grow in the coming years.

"We are operating in one of Europe's strongest economies and one of the biggest telecoms markets on the continent," Rene Schuster, Chief Executive of Telefonica Germany said.

Parent company Telefonica cut its dividend payment in July for the first time since the Spanish Civil War in the 1930s to help cut its 57 billion euro debt pile. It also wants to sell off assets and list other parts of its business in Europe and abroad.

O2 Germany's net debt stood at 1.1 billion euros at end-September. ($1 = 0.7731 euros)

(Reporting by Sonya Dowsett, Additional reporting by Alexander Huebner and Harro Ten Wolde in Frankfurt, Writing by Clare Kane. Editing by Jane Merriman)

((clare.kane@thomsonreuters.com)(+34 91 585 2130)(Reuters Messaging: clare.kane.thomsonreuters.com@reuters.net))